"To get rich is glorious." -- Deng Xiaoping. This is perhaps the smartest thing ever uttered by a member of the Communist Party.

Tuesday, March 19, 2013

Is capitalism moral?

Writing in Sunday's Washington Post, Steven Pearlstein -- no doubt a familiarfigure to longtime readers of this blog -- poses the question of whether capitalism is moral. While he never quite gets around to directly answering his own query, perhaps this John Mackey quote should be considered in attempting to resolve matters:

The beautiful thing about capitalism is that it’s ultimately based on voluntary exchange for mutual benefit. Take a business like Whole Foods Market, for example: we create value for our customers through the goods and services we provide for them. They don’t have to trade with us; they do it because they want to, because they think it’s in their interest to do so. So we’re creating value for them. We create value for the people who work for us: our team members. None of them are slaves. They are all voluntarily working because they feel like it’s a job they want to do; the pay is satisfactory; they derive many benefits from working at Whole Foods, psychic as well as monetary. So we’re creating value for them.

Exactly. Capitalism is moral because it is a system based on free will and voluntary transactions rather than coercion. The same, it must be noted, cannot be said of government. Contrary to Sen. Harry Reid's assertion, surrendering one's wealth to the state in the form of taxes, for example, is not a voluntary exchange. Those who refuse to pay tax or comply with regulations and laws imposed by government face very real sanctions such as fines and prison time. Given this reality, perhaps a more relevant question is not the morality of capitalism, but government.

While the column is far too lengthy to go through point by point, there are several statements and assertions deserving of greater scrutiny. In making the argument for capitalism's dubious morality, Pearlstein offers up the following:

More recently, we’ve seen another side of free markets: stagnant incomes, gaping inequality, a string of crippling financial crises and 20-somethings still living in their parents’ basements.

But how are we to know that these the result of free markets? We live, after all, not in some free market ideal, but rather a system where government spending accounts for roughly 40 percent of economic output. Why should any of those items be attributed to markets rather than government? Pearlstein is making an assertion rather than a reasoned argument.

Shortly thereafter, Pearlstein not highlights the views of the heads of the conservative American Enterprise Institute and libertarian Cato Institute:

As they see it, regulation is an infringement of individual liberty, while income redistribution, in the form of a progressive tax-and-transfer system, is nothing more than thievery committed against the most talented and productive by those who are not.

While the exact nature of taxation is open for debate, regulation is a pretty open-and-shut case. Serving as a constraint on human behavior, it is almost by definition an infringement on liberty. Although this diminishment of individual liberty may prove a net gain to human welfare in certain instances -- such as restrictions on pollution -- it is impossible to pretend that it does not result in a reduction of personal freedom. This may be an uncomfortable reality for those who support increased levels of government regulation, but it is reality nonetheless.

Pearlstein expands upon regulation later in the column:

The conservative case against regulation, for example, is premised on the proposition that everything that has gone wrong with the markets is the government’s fault. That’s the explanation for the recent financial crisis offered by Allison, who, before taking over at Cato, built BB&T from a local bank into a regional powerhouse. Allison’s culprits are the Federal Reserve, federally chartered Fannie Mae and Freddie Mac, federal deposit insurance, and misguided bank regulations designed to make credit available to low-income households.

I asked Allison recently about mortgage bankers who made lousy loans that they knew would go bad, and investment bankers who knowingly packaged them into securities, and ratings agencies that gave them their seal of approval. His explanation was that once a misguided government provided the wrong incentives and opportunities, such profit-maximizing behavior was to be expected in a market system — a system that eventually would have punished those who were misguided or unethical if the government hadn’t foolishly bailed them out.

Note the Gordon Gekko-like logic here: Because pursuit of self-interest is the essential ingredient in a market system, it somehow follows that individuals and firms are free to act as greedily and selfishly as they can within the law, absolved from any moral obligations.

Note the contrast here: Allison makes the reasoned argument that government interference with the market provided incentives for people to do bad things, while Pearlstein simply thunders against Allison's recognition of human nature and failure to engage in moralizing. But if one is actually interested in protecting people, isn't it best to rely on a system -- such as capitalism -- which ruthlessly punishes ill treatment of one's customers rather than people operating by a moral code? How many companies survive and prosper for any real length of time in a free market environment through intentional abuse and deceit of their customers?

That people will behave badly when provided with the opportunity should be no surprise -- human imperfection is the entire reason government exists. Rather than trying to improve people and their moral code, however, isn't effort better expended on identifying and correcting those skewed incentives which led to such poor outcomes?

Towards the column's conclusion Pearlstein raises the issue of redistribution:

There remains, however, one glaring problem with the moral case against redistribution. For implicit in the imperative to let the productive keep what they earn is an assumption that the markets distribute income in a way that accurately reflects everyone’s relative economic contribution — and therefore is fair. But is that true?

In an economy of self-sufficient farmers and ranchers, people can point to something and credibly claim, “I produced that” or “I built that.” But in a modern, complex economy, the connection between what is produced and who is responsible for producing it is not so obvious. Modern business is a team sport.

Of course compensation reflects contribution! If it didn't, and someone was being underpaid for their output, that person would be hired away -- greedy capitalists are forever on the hunt for arbitrage opportunities. The complexity of the economy, meanwhile, is irrelevant. The price mechanism is an excellent way of cutting through the chaff in order to determine how much value is contributed by each piece of the economic engine. Pearlstein appears to be deliberately confusing the issue in order to built doubt around capitalism's virtues.

It was only 20 years ago, for example, that wage and salary earners reliably captured about 75 percent of the national income, with the rest going to the providers of capital. But in recent years, labor’s share has fallen closer to 67 percent.

So what? These shifts in allocation simply mean is that capital is valued more highly than labor. If this wasn't the case, people would pay more for labor. Pearlstein's use of income share also serves to obfuscate matters -- isn't the more relevant metric actual take home pay? One suspects that Pearlstein is clever enough to realize that one-third of a birthday cake is typically larger than 100% of a cupcake, so why is he so keen on using percentages here?

A similar shift in the distribution of rewards has occurred within firms and within industries, with much more of the income captured by superstar performers or those at the top. Fifty years ago, the typical corporate chief executive earned less than 50 times the pay of the average front-line worker. Today, the ratio is closer to 350 to 1.

Again, what is the revelance? This simply tells us that CEOs have become more valuable. If they weren't, companies -- who are typically not interested in spending more money than what is necessary, at least if they wish to remain in business -- wouldn't pay them so much.

These shifts suggest that the way markets distribute rewards is neither divinely determined nor purely the result of the “invisible hand.” It is determined by laws, regulations, technology, norms of behavior, power relationships, and the ways that labor and financial markets operate and interact. These arrangements change over time and can dramatically affect market outcomes and incomes.

If Pearlstein freely acknowledges that laws and regulations shape so much of the outcomes we see, then why is he talking about free markets? How can he both attribute financial crises and stagnant incomes to the free market earlier in the column while later on admitting that government helps shape such outcomes? Shouldn't the conversation be more about the perverse incentives that arise because of government?

This poses a dilemma for those making a moral case for free markets. If providers of capital could lay a moral claim to 25 percent of the nation’s income as recently as the early 1990s, why do they have a moral claim to 35 percent today? If the top five executives in a big public corporation could once lay claim to 2 or 3 percent of its profits, what gives them the moral right to 10 percent today?

Easy: Because capital and CEOs are more valuable today than in the past. Why is Pearlstein pretending that something so obvious is so difficult to figure out?

And what possible moral justification could there be for a system in which, for every dollar of increased output resulting from higher worker productivity, a mere 13 cents now goes to the typical worker in higher pay and benefits?

The justification is that the worker's contributions aren't enough to justify higher returns. A moral system pays people what they are worth, and the free market pays people what they are worth by definition. Again, if the worker was under-compensated, someone else would hire them away and pay them more.

For all of the seeming conundrums and questions raised by Pearlstein, the answers are surprisingly easy, leaving one to wonder whether the author is being deliberately obtuse. Capitalism is beautiful both in its simplicity and reliance upon free will, both of which stand in stark contrast to the machinations of politicians and coercive nature of government. In the present environment we need more of the former and less of the latter.